An announcement by HM Revenue and Customs providing clarity about the tax treatment of hundreds of thousands of personal contract purchase (PCP) and similar contracts in the UK has been welcomed by the industry.
The briefing note follows a European Court of Justice ruling on a legal wrangle between HMRC and Mercedes-Benz Financial Services over its ‘Agility’ product.
At the heart of the row was how to interpret at key part of VAT rules on whether PCPs are a supply of goods or services.
Previously, HMRC regarded them as goods, with a separate supply of credit. Following an ECJ ruling in favour of MBFS, tax rules have been amended and consider that some of these contracts can be seen as a single supply of taxable leasing services.
Simon Goldie, head of asset finance at the FLA, said: “We welcome the clarity provided by HMRC’s briefing note on the treatment of personal contract purchases and similar contracts.
“Having worked with HMRC to avoid any adverse impact on the asset finance and motor finance industries, we are pleased to see that the briefing adopts the FLA’s recommendations, and provides the common sense approach that our members suggested.”
The initial ruling and the HMRC briefing relate to balloon payments and how they reflect the value of an asset.
If the fee is below the anticipated market value of the asset, supplies are not affected by the MBFS ruling, regardless of the level at which the balloon payment is set.
For affected PCPs and similar contracts, their VAT treatment depends on the level at which the final optional payment is set.
If, at the start of the contract, it is set at or above the anticipated market value of the goods at the time the option is to be exercised, the VAT treatment of the contract treats it as a supply of leasing services from the outset and VAT must be accounted for on the full value of each instalment. The briefing said: “There is no advance, or credit, so there is no finance.”
However, if, at the start of the contract, the final payment is set below the anticipated market value, so that a “rational customer” would buy the asset when they exercise the option, it is seen as a supply of goods, with a separate supply of finance. VAT is due on the supply of goods in full at the outset of the contract, the finance is exempt from VAT.
The ruling places the spotlight on residual value setting within finance companies for PCP contracts, as this is the key to whether the balloon payment accurately reflects the future market value of the asset.
HMRC said it will generally accept that the optional payment is set below the anticipated market value “if it is below the value expected based on historical depreciation rates in immediately preceding years for the same or similar assets, such as the same model of car”.
Finance companies may use another method to establish an accurate residual value that reflects the open market for the asset, as long as there is proof of a “credible assessment”.
This means companies must maintain, as part of their business and accounting records, evidence which demonstrates how they have arrived at the figures they have used.
Businesses must adopt the correct treatment for all new contracts no later than June 1, 2019 and must review current contracts to identify any errors in tax payments.
HMRC also said that customers that have recovered VAT on PCP contracts, which their supplier amends in the light of the MBFS judgement, must adjust their claim accordingly.
Last year, FLA members financed more than 90% of private new cars sales through contracts worth £37 billion.